Meeting with South African Reserve Bank Governor

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Finance Standing Committee

02 August 2007
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Meeting report

FINANCE PORTFOLIO COMMITTEE
3 August 2007
MEETING WITH SOUTH AFRICAN RESERVE BANK GOVERNOR

Chairperson:
Mr N Nene (ANC)

Documents handed out:
South African Reserve Bank presentation on international and domestic economic developments (with commentary)
 
WAV Recording of meeting

SUMMARY
The South African Reserve Bank indicated that the global economic growth remains relatively robust and the outlook continues to be favourable. Projections for global growth both in 2007 and 2008 have been revised upwards by 0.3 percentage point from April 2007 according to the International Monetary Fund (IMF) World Economic Outlook. Global growth is set to amount to 5,2 per cent in both 2007 and 2008. However financial market risks from greater volatility and lower credit quality have become a greater concern.

Real GDP growth in the advanced economies is expected to slow to 2,6 per cent in 2007 and 2,8 per cent in 2008. This is 0,1 percentage point higher than projected at the time of the April forecast. The forecast for US growth has been revised downward by 0,2 percentage point to 2,0 per cent in 2007 and is expected to return to potential in 2008. Emerging markets are expected to continue to grow at a much faster pace than advanced economies underpinned by rapid growth in China, Russia and India.

The inflation trends in the Southern African Development Community (SADC) countries remain mixed and in the last twelve-month the rate of change in the consumer prices of the SADC countries ranged between 5,9 per cent for Tanzania and 12,4 per cent for Angola. The annual consumer price inflation in June accelerated in Lesotho, Mozambique, South Africa and Tanzania while it decelerated in Madagascar, Malawi, Mauritius, Namibia and Zambia.

The South African economy continued to grow in the first quarter of 2007 though at a slower pace. The growth in real Gross Domestic Product (GDP) moderated from an annualized rate of 5 ½ per cent in the fourth quarter of 2006 to 4 ¾ per cent in the first quarter of 2007. The slow growth in the first quarter of 2007 was mainly due to a decline in the real value added by the primary sector. In addition, growth in the real value added by the secondary sector slowed. Growth in the real value added by the non agricultural sector slowed from an annualized rate of 6 per cent in the fourth quarter of 2006 to 4 ½ percent in the first quarter

MINUTES
The Governor of the South African Reserve Bank (SARB), Mr Tito Mboweni, was accompanied by two people from his team, the Head of the National Accounts Division Research Department and his Chief Economist. The Chief Economist outlined the focus of the presentation which would include international and domestic economic developments and key areas of concern for the Bank.

In the international economic development arena, central banks across the world have steadily increased official interest rates in response to the rising inflationary pressure in the recent months. Since January 2007, monetary policy has been tightened by countries like Canada, Chile, China, Czech Republic ,Denmark, the euro zone, India, Japan, Mexico, New Zealand, Poland, South Korea, United Kingdom, Taiwan and Switzerland due to increased consumer spending, while by contrast, countries like Brazil, Hungary, Russia and Thailand have lowered their interest rates.

Although the global inflation remains contained in the 2007 figures for advanced economies, the IMF World Economic Outlook has revised emerging markets and developing countries marginally upwards in July 2007 due to the inflationary pressures from higher energy and food prices. Inflation in advanced economies is projected to register an upward revised 2,0 percent in 2007 before increasing somewhat to 2,1 percent in 2008. Emerging markets and developing countries are expected to experience inflation of 5,7 per cent in 2007 and 5,0 per cent in 2008. The risks to the inflation outlook have increased due to greater supply constraints as result of continued strong growth as well as higher oil prices.

Following a slight recovery in the fourth quarter of 2006 on the domestic front, the real value added by the primary sector declined at an annualized rate of 4 ½ per cent in the first quarter of 2007. A contradiction in real output by mining sector neutralised an increase in real value added by the agricultural sector in the first quarter of 2007.

The growth rate in real value added by the secondary sector from an annualized rate of 8 ¾ per cent in the fourth quarter of 2006 to a rate of 7 per cent in the first quarter of 2007. This was mainly due to the slower growth recorded in real output by the manufacturing sector. The real value added by the tertiary sector rose at an annualized rate of 5 per cent in the first quarter of 2007, the same rate attained in the fourth quarter of 2006. This was the net result of marginally higher growth rates in real value added by sub-sectors in transport, storage, communication, community, social and personal services. These were fully offset by slower growth in the real output recorded by commerce and the finance, insurance, real estate and business services sector.

Although it is still exceeding the rate of growth in gross domestic product, the rate of growth in real gross domestic expenditure (GDE) slowed considerably in the first quarter. The growth aggregate of real gross domestic expenditure slowed from an annualized rate of 12 ¼ per cent in the fourth quarter of 2006 to 5 ¾ per cent in the first quarter of 2007. The slower growth could mainly be attributed to a much slower pace of inventory accumulation, while growth in the real final consumption expenditure by household was marginally below that of the final quarter in 2006. By contrast, growth in real final consumption by general government expenditure and gross fixed capital formation accelerated significantly in the first quarter of 2007.

The real final consumption expenditure by household increased at an annualized rate of 7 ½ per cent in the first quarter of 2007 compared with a growth rate of 7 ¾ per cent in the fourth quarter of 2006. The slight moderation in growth was mainly due to much slower growth in spending on services over the period. However growth accelerated in the semi-durable and non durable spending categories.

In the light of households experiencing a slightly stronger increase in real disposable income, growth in real disposable income accelerated from an annualized rate of 7 ¼ per cent in the fourth quarter of 2006 to 7 ½ per cent in the first quarter of 2007. This can mainly be attributed to an increase in employment and the fact that wage settlements were on average or above the upper limit of the inflation target range. This increase in disposable income has upscaled household debt from 73 ¾ in the fourth quarter of 2006 to 76 per cent in the first quarter of 2007. In addition household debt service costs as a percentage of disposable income increased from 9 per cent in the final quarter of 2006 to 9 ½ per cent in the first quarter of 2007.

By contrast to the latter, the real final consumption expenditure by general government picked up strongly and recorded an annualized increase of 4 ¾ per cent in the fourth quarter of 2006 and it further accelerated at a rate of 14 per cent in the first quarter of 2007. This raised the ratio of final consumption expenditure by general government to gross domestic product slightly, to 19 ½ per cent from 19 ¼ per cent in the fourth quarter of 2006. The higher level of government expenditure can partly be explained by the purchase of another submarine during the first quarter of 2007.

The economy has also experienced growth in real fixed capital formation from an annualized rate of 16 ½ percent in the fourth quarter of 2006 to 21 ¾ per cent in the first quarter of 2007. This was mainly due to buoyant growth in real gross fixed capital formation by public corporations. In addition the real gross fixed capital formation by both private business enterprises and general government continued to increase in the first quarter of 2007. Consequently the ratio of gross fixed capital formation to gross domestic product rose from 19 ½ per cent in the fourth quarter of 2006 to 20 ¼ per cent in the first quarter of 2007.

In the last few years government has been calling on South Africans to consider savings as part of their household spend. This call has yielded some positive marginal increases, from 13 ½ per cent to 14 ½ per cent in 2006. The ratio of the gross savings to the GDP was 14 ¾ percent in the first quarter of 2007. This improvement in the national saving ratio was the result of improved saving ratios in the household, corporate as well as the general government sector.

The South African economy has experienced consistent and robust growth which has spurred on growth in employment. In the first quarter of 2005 according to the Statistics South Africa’s Quarterly Employment Statistics (QES) survey, employment levels increased consistently during the subsequent two years after the employment lapse in 2005. This was measured at a seasonally adjusted and annualized rate. Employment levels showed an increase by 2,9 per cent in the fourth quarter of 2006 and increased further by 3,8 per cent in the first quarter of 2007. When measured over the period of four quarters, employment had increased by 2,9 per cent in the first quarter of 2007. Private sector employment increased by 2,6 per cent in the four quarter period while public sector employment increased by 3,9 per cent. Following further increases in employment, economy-wide labour productivity growth moderated from a year-on -year rate of 3,1 per cent in the fourth quarter of 2006 to 2,4 per cent in the first quarter of 2007.

Recently production price inflation reached a high in May 2007 before inching lower in June 2007. Year-on-year imported goods production price inflation almost tripled from 4,7 per cent in May 2006 to 11,7 per cent in May 2007 following increases in commodity prices during this period. Higher food prices also helped push this index into its highest levels in more than four years. While domestically produced goods price inflation accelerated remarkably from year-on-year rate increase of 5,0 per cent in March 2006 to 11,2 per cent in April 2007. However it subsequently declined marginally to 10,8 percent in June 2007 following a decline in mineral production prices. A slowdown in both imported and domestic goods inflation yielded an all-goods production price inflation of 10,4 percent in June 2007.

The Consumer Price Index (CPIX) inflation breached the upper limit of the inflation target range for the third consecutive month in June 2007 from 3 to 6 per cent since September 2003. However in April 2007 it breached the upper limit target on the inflation range amounting to 6,3 percent and edged higher to 6,4 per cent in May and June 2007. Higher rates of increase in CPIX services prices were fairly widespread in recent months, increasing from a year-on-year rate of 3,3 per cent in June 2006 to 5,7 per cent in June 2007. This was led by amongst others an increase in domestic worker wages and the rental component in the home owners category. The year-on-year CPIX goods price inflation accelerate from 5,1 per cent in October 2006 to 6,8 per cent in June 2007 driven by higher food and petrol prices.

In the balance of payments, the current account deficit narrowed during the first quarter of 2007 to R131,0 billion from R143,0 billion in the fourth quarter of 2006. The improvement in the trade account countered the further widening in the shortfall on the country’s services and income account with the rest of the world (in percentage terms the ratio narrowed from 7,8 per cent to 7,0 per cent over the corresponding period). Despite an increase in the value of imported mineral products during the second quarter if 2007, preliminary estimates suggest that the deficit on the trade account narrowed somewhat as the foreign demand for South African mining products increased.

In the balance of payments, the financial account remained in surplus in the first quarter of 2007 following record inflows for the 2006 calendar year. The net capital inflow on the financial account amounted to R32,7 billion in the first quarter of 2007 compared to an inflow of R43,0 billion in the fourth quarter of 2006. The interest shown by foreign direct investors in general and private equity funds in particular in South African companies bodes well for the future direct investment related inflows.

The exchange rate of the Rand recovered during the second quarter of 2007 following a decline in the first quarter of 2007. It appreciated by 1,8 per cent during the second quarter of 2007 compared to the depreciation of 4,4 per cent in the first quarter of 2007. The real significance of the exchange rate depreciation over the last twelve months is that it strengthens the competitiveness of South African exports in global markets.

The inflation expectations rose with the release of the worse than anticipated inflation data and high price of oil. The break-even inflation rate is approximated by the difference between the nominal yield on conventional governments bonds and real yield on government linked bonds within the six year maturity range. This has increased from 4,71 per cent in February 2007 to 5,76 per cent in July 2007 following a significant increase in the yields on conventional bonds while real yields on inflation linked bonds remained at the same level.

Government finances continue to be supportive of a disciplined monetary policy environment. National government revenue for the first quarter of fiscal 2007/08 amounted to 120,8 billion or 15,8 per cent more than in the same period of the previous fiscal year. Government expenditure was above revenue during the first quarter of fiscal 2007/8 - a cash book deficit before borrowing and debt repayment of R4,9 billion was recorded. The budget review of 2007 indicates a public-sector deficit of R5,1 billion or 0,3 per cent of gross domestic product in the fiscal 2007/08.

In conclusion the Governor indicated that the two primary commodities that are putting inflationary pressure on the South African economy is food and petrol prices. The standard of living for people in the emerging markets has improved considerably and there is increased demand for the type of food utilized in the advanced economies. The domestic economy would continue to grow as long as Chinese consumers had an appetite for South African goods.

The IMF World Economic Outlook projected the Chinese economy to grow at 11 per cent per annum, while the US economy was slowing down due to a number reasons including oil prices.

Discussion
Mr B Mnguni (ANC) sought clarification on whether the recent wage settlement had any impact on the unit cost of production. He also asked about the possibility of including Zimbabwe in the common market area as a mechanism to reduce interest rates, inflation and to overcome the economic crisis.

Governor Mboweni replied that he did not endorse an approach that used CPIX for wage negotiation for various reasons. Rather he would support wage negotiations that consider cost of living because it is more realistic in comparison to CPIX. The bank would be concerned about wage settlements that are above inflation, but the recent public sector wage settlement was within the inflation threshold, therefore the bank was not in a panic nor too concerned about the ultimate settlement.

In terms of the inclusion of Zimbabwe in the common market area in the Southern African Development Community (SADC), his response was that the current common market area in the SADC region is the Southern African Customs Union (SACU) and Zimbabwe was not a member. Normally when countries are part of a common market area, they are expected to comply with certain policies such as budget deficit should not be more than 5 per cent. With the economic situation in Zimbabwe, the latter was out of the question. In addition, SACU had some policy challenges that should be resolved. It would complicate the situation further if Zimbabwe would be admitted as a member of the Union.

Mr D Gibson (DA) asked if the Governor agrees with the Harvard economists that South African should be reducing its interest rate as a vehicle to suppress inflationary pressure. He asked how much influence did the group of Harvard economists have in the final policy making process . He also asked if there could be trade-offs between growth in employment with inflation.

In response, Governor Mboweni indicated that the Harvard economists acted as a sounding in economic policy discussion and they contributed in the debate broadly. However, the Governor did not agree with the view that monetary policy had no role in suppressing inflationary pressure. The Harvard economists had no final word in the policy directives of the South African economy and the Bank did not always concur with their perspective on economic direction. In terms of trade-offs between growth in employment and inflation, there were none.

Dr G Woods (NACEDO) asked if the commodity boom was sustainable and healthy for the economy of South Africa and whether the Bank was involved in the government’s 2010 infrastructure projects.

Governor Mboweni gave a speculative response that as long as the demand from China continued for South African goods, the economy would be buoyant. The South African interest rates were high and yield seekers would always move around and look for return in their investment. The Bank was tracking the development and growth of the construction sector as result of the 2010 infrastructure investment projects.

Mr L Johnson (ANC) asked if the Bank was considering alternative sources of energy, in particular maize, given the constant increase in the global oil prices. He asked if the new National Credit Act was making an expected impact on consumer spending to reduce inflationary pressure in the economy. He also sought clarification on whether employment growth was making an expected dent in reducing poverty levels and income distribution.

Governor Mboweni replied that the issue of alternative sources lay in the domain of the Department of Minerals and Energy (DME). He was aware from secondary sources that DME was considering alternative sources of energy. He cautioned the DME, in absentia, that they should not consider maize due to its limited supply. They should rather consider sugar cane as an alternative.

In terms of the National Credit Act, the Governor indicated that it was too early to judge or measure the impact of the Act but early observation was that the Act would yield the expected results. The Bank could not provide an authoritative view on the impact of growth in employment to poverty levels because the mandate of the Bank was price stability. Statistics SA would be better placed to comment on the matter and provide a credible viewpoint.

Mr B Mnguni (ANC) asked if Zimbabwe’s inflation would drop by 2014? He also sought the Governor’s view on what happens if the Governor did not meet the inflation target.

Governor Mboweni replied that the real crisis in Zimbabwe was that technical issues (monetary policy issues) could not be resolved exclusively from political policy matters and currently that was the standoff in Zimbabwe. Unless the political situation changed, the stalemate in the economic arena would not be resolved. In relation to inflation targeting, the Governor indicated that the bank was doing considerable work to control inflation but, it required other critical players in the economy to support the Central Bank’s work. For example, if Eskom introduced an electricity hike of 18%. This would lead to an increase in interest rates to dampen the electricity increase.

Mr S Dithebe (ANC) asked if the National Credit Act had any impact in reducing indebtness and household consumption. Was there a possibility of reducing interest rates if the Act showed positive results in consumption expenditure?

In response, Governor Mboweni indicated that when the bank increased or considered increasing interest rates it took into account a number of aspects in the operation of the economy, consumption expenditure was one element, prices, unit costs of production and unit labour costs. It was a basket of elements that were critical to the operation of the economy.

Mr D Gibson (DA) sought the views of the Governor on whether there were any measures in place to encourage savings and incentivise people that are saving in South Africa.

In response Governor Mboweni indicated that he could not remember offhand but there were government internal discussions on incentives for those that are saving. In addition the message of responsible budgeting and borrowing should continue. He further indicated that low income earners were in a predicament because they did not have a disposable income to save due to well-known reasons.

Dr G Woods (NACEDO) asked if credit extension was the primary basis for the Central Bank’s increased interest rate.

The Governor replied that credit extension did not provide a sufficient ground to increase interest rates. There were other elements at play such as prices and unit labour costs.

In closing, the Chairperson expressed his gratitude to the Governor and his team and indicated that the Committee was looking forward to being hosted by the South African Reserve Bank on the 17 August 2007.

The meeting adjourned.

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